Provident Financial Services, Inc

Good morning and welcome to the Provident Financial Services, Inc. Second Quarter Earnings Conference Call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then one on your touchtone phone. To withdraw your question, please press star, then two. Please note this event is being recorded. I would now like to turn the conference over to Mr. Leonard Gleason, Investor Relations Officer. Please go ahead.

Thank you, Carrie. Good morning, ladies and gentlemen. Thank you for joining us for our second quarter earnings call. Today's presenters are Chris Martin, Chairman, President, and CEO, and Tom Lyons, Senior Executive Vice President and Chief Financial Officer. Before beginning the review of our financial results, we ask that you please take note of our standard cautions as to any forward-looking statements that may be made during the course of today's call. Our full disclaimer is contained in this morning's earnings release, which has been posted to the investor relations page on our website, provident.bank. I'm pleased to introduce Chris Martin, who will offer his perspective on our second quarter. Chris?

Thanks, Len, and good morning, everyone. As we begin the summary of our second quarter, it is our sincere hope that you and yours are safe and healthy. Second quarter earnings were impacted by COVID and CECL as the provision for low losses and expenditures related to providing a safe environment for our customers' employees took priority as we phased our staff back to office process and afforded our customers full branch access. On a positive yet related note, we had expenses for the planned acquisition of SB1 of $683,000 during the quarter and looked to complete the closing tomorrow. We remain comfortable with our capital structure and balance sheet strength. Our capital ratios continue to be strong given our business mix and risk management processes. In view of our capital and pre-tax pre-provision earnings expectations, the Board approved a $0.23 cash dividend. Net income for the quarter was $14.3 million, or $0.22 per share. Net interest margin decreased 23 basis points linked quarter to 2.97% as the impact of lower rates and higher cash balances was partially offset by lower deposit costs and above average growth in non-interest bearing deposits.

The impact of PPP loans on our margin was two basis points.

And we continue to experience a reduction in our all in cost of deposits to 41 basis points for the quarter ended June 30th, 2020 versus 62 basis points from the trailing quarter. Borrowing costs also improved to 1.31% for 1.80% in the trailing quarter. The decrease in earning asset yields at 45 basis points linked quarter reflects falling benchmark interest rates on adjustable rate loans accompanied by modest growth and new originations at lower rates and the $403 million in PPP loans. And of the PPP loans, we are assuming that approximately 75% to 80% will be forgiven once the government provides the vehicle and forms to complete this. The impact on our net interest margin from the short end of the curve is now largely behind us, but historically low long-term rates will continue to put pressure on asset yields as our loan and investment portfolio is repriced at lower coupons. The loan pipeline remains robust at $1.3 billion. and activity continues to provide us with growth potential as payoffs have ebbed during COVID. We are also placing interest rate floors on most of our commercial loans. Residential mortgage originations have spiked as rates hit historical lows and neighborhoods experience an upsurge in activity with more individuals working from home and assimilating to the new work environment, which we see as continuing well into the future. Unlike some banks, We did not experience a high level of line draws during the course of the economic shutdown, as line usage remained at 36%. We view this as indicative of the stability of our customer base and their assurance in our capacity to support their funding needs. Now, Tom will go into more details on loan deferrals, but suffice it to say the initial phase of 90-day deferrals peaked at approximately $1.3 billion, or 16.8% of the loan portfolio. This has been reduced to $395 million, or 5.1% of loans. This includes second deferrals to date of $343 million. The increase in deposits is difficult to parse, as much of the growth can be attributed to PPP loans, along with stimulus checks from the government. But in any event, significant growth in non-interest-bearing deposits help reduce our funding costs. Non-interest expense declined during the quarter due to decreased deposit-related fees as much of our market was under the stay-at-home executive orders which impacted debit card revenue due to reduced volumes. While management income was also affected by the market declines in the value of assets under management which has since recovered. On the non-interest expense front, the majority of the $5.6 million increase was due to CECL and the credit loss expense for off-balance sheet accredited exposures of $5.3 million in the quarter. We also had increases in data processing expenses related to our digital platform improvement along with transaction costs associated with the SB1 acquisition. Asset quality improved and we experienced net recoveries for the quarter. Our allowance for credit losses now stands at 1.11% of total loans from 0.76% at December 31st, 2019. The provision in the quarter was significantly impacted by Moody's baseline economic forecast, including a negative shift in the outlook for commercial real estate. Exposures to hotels, retail, restaurants, and skilled nursing facilities are under heavy scrutiny. Our June 30 reported credit metrics remain remarkably stable given the ongoing level of economic stress as borrowers were aided by the impact of government stimulus and loan modification and deferral programs. We envision continued pressure on credit as we anticipate the continuation of a challenging business environment due to the pandemic. And we anticipate meeting all of our cost savings from the combination of SB1 Bancorp, which closes tomorrow, and all that we'll provide to our customers and our employees, while also increasing long-term growth and stockholder value. Now, Tom will provide more detail on our financial results. Tom?

Thank you, Chris, and good morning, everyone. As Chris noted, our reported net income was $14.3 million, or $0.22 per diluted share, compared to $24.4 million, or $0.38 per diluted share, for the second quarter of 2019, and $14.9 million, or $0.23 per diluted share, in the trailing quarter. Earnings for the current quarter were again adversely impacted by elevated provisions for credit losses under the CECL standard and a recessionary economic forecast attributable to the COVID-19 pandemic. In addition, we incurred costs specific to our COVID response, including supplemental pay for customer-facing employees, PPE, equipment, and security costs, and costs related to the upcoming merger with SB1. Four pre-tax, pre-provision earnings were $35.9 million, excluding $16.2 million in provisions for credit losses on loans and commitments to extend credit, $1 million of COVID costs, and $683,000 of professional fees related to the SB1 merger. This compares with $36.4 million in the trailing quarter, excluding provisions for credit losses and merger-related charges, and $42.7 million for the second quarter of 2019. Our net interest margin contracted 23 basis points versus the trailing quarter and 45 basis points versus the same period last year. As declining market interest rates, cash collateral pledged against out-of-the-money swaps, excess liquidity, and PPP loans all produced lower earning asset yields. To combat margin compression, We continue to reprice deposit accounts downward. This deposit rate management coupled with a continued emphasis on attracting non-interest bearing deposits resulted in the 21 basis point decrease in the total cost of deposits this quarter to 41 basis points. Non-interest bearing deposits averaged $1.8 billion or 25% of the total average deposits for the quarter. This was an increase from $1.5 billion in the trailing quarter with a sizable portion of that growth attributable to PPP and stimulus funding. Non-interest-bearing deposit levels remained elevated at $1.9 billion on June 30th. Average borrowing levels increased $92 million, and the average cost of borrowed funds decreased 49 basis points versus the trailing quarter to 1.31%. We will continue to thoughtfully manage liability costs as the rate environment evolves. Quarter-end loan totals increased $294 million versus the trailing quarter, as growth in CNI, CRE, multifamily, and residential mortgage loans was partially offset by net reductions in construction and consumer loans. The growth was largely driven by PPP loans, which totaled $400 million at June 30th. Loan originations excluding line of credit advances totaled $774 million for the quarter. The pipeline at June 30th was consistent with the trailing quarter at $1.3 billion. The pipeline rate has increased 26 basis points since last quarter to 3.43% at June 30th. Our provision for credit losses on loans was $10.9 million for the current quarter, compared with $14.7 million in the trailing quarter. The decrease in the provision reflects a significant reserve bill required in the trailing quarter and ceaseless model estimates for life of loan losses as impacted by the ongoing severe economic forecasts. We had annualized net recoveries as a percentage of average loans of one basis point this quarter, compared with annualized net charges of 16 basis points for the trailing quarter. Non-performing assets declined to 37 basis points at total assets from 39 basis points at March 31st. The allowance for credit losses on loans to total loans increased to 1.11% or 1.17% excluding PPP loans from 1.02% in the trailing quarter. Loans with short-term COVID-19 payment deferrals declined from their peak of 1.31 billion or 16.8% of loans to 395 million or 5.1% of loans. Loans in deferral consist of $52 million that are still in their initial deferral period and another $343 million that have been or are expected to be granted a second 90-day deferral. Included in this total are $130 million of loans secured by hotels with a pre-COVID weighted average LTB of 53%, $124 million of loans secured by retail properties with a pre-COVID weighted average LTB of 66%, and 25 million of loans secured by restaurants with a pre-COVID weighted average LTV of 59%. Of the 912 million of loans that have concluded their deferral period, 380 million have resumed regular contractual payments with the majority of the remainder expected to resume payments at their August 1st due date. Non-interest income decreased 2.6 million versus the trailing quarter to $14 million as reductions in deposit and wealth fees resulting from consumer restrictions from COVID mitigation efforts and volatile asset values and lower swap fee income was partially upset by greater bank-owned life insurance benefits and gains on sales of real estate owned. Excluding provisions for credit losses on commitments to extend credit, COVID-related costs and acquisition-related professional fees, non-interest expenses were an annualized 1.86% of average assets for the quarter. These core expenses decreased $4.4 million versus the trailing quarter. The decrease in court expenses versus the trailing quarter was primarily attributable to $1 million of executive severance and normal first quarter increases in compensation and related payroll taxes recognized in the trailing quarter and increased deferral of salary expense related to PPP loan originations in the current quarter. This improvement was partially offset by increased FDIC insurance costs as the remaining $267,000 in small bank assessment credit was utilized in the current quarter. Our effective tax rate decreased to 20.6% from 26% for the trailing quarter as a result of a reduced forecast of taxable income in the current quarter and an adverse discrete item related to divesting stock compensation in the trailing quarter. We are currently projecting an effective tax rate of approximately 23% for the balance of 2020. That concludes our prepared remarks. We'd be happy to respond to questions.

We will now begin the question and answer session. To ask a question, you may press star then 1 on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then 2. At this time, we will pause momentarily to assemble our roster. First question will come from Mark Fitzgibbon of Piper Sampler.

It's John Naviolan for Mark this morning. Good morning, gentlemen. Good morning. I wondered if we could just start by potentially giving us an update on asset flows in your wealth management business and just remind us what AUM was as of March 31st and then as of the end of the most recent quarter. Sure, John.

AUM at March 31st was $2.8 billion and at the end of June, $3.2 billion. So we've recovered, but on an average basis for the quarter, We're down about $100 million. $3.2 billion to the average in Q1 versus... I guess $3.2 billion to the average in Q1 versus $3.1 in Q2. Got it.

Got it. And then the pipeline does look strong, down just a touch quarter over quarter to $1.3 billion. How much would you expect to close in 3Q? I think you normally are looking at a 50%-ish pull-through rate.

Yeah, 58% is the expected pull-through rate at a...

a rate of about 3.43 3.43 okay fantastic and I appreciate the initial color on the margin but I was hoping we could maybe dig a little bit deeper on the outlook specifically for the back half of the year given not only the closing of SB1 tomorrow but also you know the blend of PPP fees through NII there's just a lot of moving parts if you could provide any clarity on that that'd be great

Sure, so inclusive of the fee income, I think PPP yields about 325. I believe that was discussed in the earnings release too. So that's assuming the regular accretion. If you're going to take the, you know, accelerate the forgiveness and book more in Q3 and 4, which is the expectation, I think about 75% is what we're projecting will be paid this year. Obviously, you see the bump on that. So the total fee income was $11.5 million collected, and we recorded about two and a half months' worth of that was accreted into income. So about $480,000 a month for two and a half months in Q2. Okay, great.

And then I guess just one last one on credit with the reserves, as you mentioned, now around 1.17% of total loans, XPPP. Do you feel comfortable with this moving forward? Or do you think maybe could be conservative to build this a little bit higher over time? I know it's subject to so many different moving parts, but

You know, it's largely model driven at this point. I mean, there's a little bit of flexibility in the qualitative factor assessment. That's where you try and account for institution specific things or things that you think might be outliers in the model, you know, depending on what's happened in the world versus the last baseline forecast, but we're going to adhere to the process. I'm comfortable with where we are. I think it's the appropriate reserve level. I don't see a huge build unless you know, it so much depends on the pandemic. So some ugly numbers as expected on GDP. Employment numbers are looking a little bit weak. So we'll have to see what comes. This is Chris.

I think on the deferral, it's going to be the second wave of this to say how much of this is part of the pandemic and how much of the businesses are going to continue to struggle. Obviously, opening up the economy in New Jersey, we've been holding back a little bit for its own protection. Pennsylvania is the same. So I think the third quarter we'll start to see who's going to be surviving, who's going to be struggling, and that'll probably add to the qualitative factors that we'll be looking at between Q3 and Q4.

We had some encouraging discussions and some good news in terms of the number of folks that have already returned to a regular payment status, but it's so much dependent on whether or not we remain in an open position and continue to do that.

Thank you, gentlemen. That's all I had. Thank you.

The next question comes from Eric Zwick of Benning and Scattergood.

Good morning, guys. Good morning. With the SB1 transaction scheduled to close tomorrow, are there any updates you can share on the loan mark and CECL assumptions you plan to record relative to the original expectations?

Unfortunately, Eric, we're still in a lot of the throes of that and really aren't prepared to discuss any of those assumptions at this point.

Okay, and then given that SB1 hasn't released 2Q results at this point, I'm assuming like most other banks, they've likely seen a buildup of liquidity during the quarter. I'm curious, can you just provide any expectations for what the average earning assets in 3Q will look like, kind of including the two-month contribution from SB1?

I think when you look at the, we're talking about earning asset returns, the slight levels, I think...

The balance of average earning assets?

Yeah, I think when you look at where they were the first quarter, second quarter, I don't see a dramatic increase. We're looking at maybe about a commercial loan growth around 6.7%, 6.9% annualized. Their portfolio has held up fairly well. Pre-payments have been not really that extreme. So we're looking forward to it being kind of contiguous to what we are.

Okay, thanks for the color there. And then turning to the deferrals, and I'm curious about the $130 million in hotels. Can you provide a mix of those hotels in terms of use, kind of business versus leisure, and then any updates you have on current occupancy rates?

Well, I think of the loans that we have that are certainly not levered in the way of loan to value, certainly the rev par is off on those. There are several, we have a few hotels right in the Newark Airport area that have struggled because obviously business travel is down. We hope that that will improve. But with the governor shutting down most of the areas that you can travel to, that will hold those off a little bit. They've been on the books for, one of them is right across from the hotel, have been on the books a long, long time. So we think that they'll get through this. It'll just be a longer time frame to recover.

It's really a mix of business and leisure portfolio. I'd say occupancies are averaging in the 30% to 50% range. Again, pretty dispersed.

A pretty even mix between business and leisure then, Tom?

Yes.

Great. And then just kind of last one for me. I'm curious if you can talk about your strategy for dealing with the loans that at the end of the second deferment period still may need some sort of accommodation and How you're thinking about the treatment in terms of non-accrual or TDR accounting and I guess ultimately what that might imply for risk rating changes and the calculation for the loan loss provision?

So we've been, you know, risk rating loans appropriately from a level of maintaining scrutiny internally, but as it affects the risk rating or the allowance calculation, those are really captured in the economic forecast at deterioration until the point when they might become impaired and they get pulled out with that individually. We are looking at the pool of second deferrals and trying to make some assessments that we think might go to a potential TDR, meaning that, as you indicated, they might not be able to come back to the normalized status at the end of the deferral period. Best guess, maybe $132 million that would be subject to some kind of TDR and longer-term resolution.

Just to make sure I understood that correctly, it seems like any potential risk-grading migration you've accounted for already in the economic outlook, so even as we move into late 3Q and 4Q, You may not need big adjustments to the provision for some of those loans. That's the expectation.

If it still works the way it's supposed to, that's the expectation. I guess that will be back-tested further if those loans become impaired and they get individually evaluated for impairment.

Great. Thanks for taking my questions. Thank you.

The next question is from Russell Gunther of DA Davidson.

Hey, good morning, guys. Good morning.

Just a quick follow-up on the deferral question. The 5%, give or take, kind of pro forma number, do you have a sense for what that could shake out when we fold in the SB1 deal, kind of pro forma percentage deferrals to the total loans?

I'm just looking at, again, unofficial conversations in the way of They had in the first quarter or first round of, we'll call it a pandemic assistant program, deferrals about, they had about 20% of the portfolio. Looking at removing those about 12%. In the second go round, they're looking at only about 2% in a second deferral. At this stage, there's still some that are in within the first deferral that they still have to evaluate. So the numbers have come down dramatically from where they were and we were also. Okay, that's great, Chris. Thank you for that.

And then, you know, with the deal closed, anything you can share in terms of, I heard you loud and clear that you expect to get all the cost saves recognized, but just remind us in terms of the timing of when you'd expect that recognition and then, you know, any thoughts around what a good pro forma expense run rate would be when those are fully recognized.

Again, I think with the cost saves, we estimated 30% cost saves. We will exceed that. We're very comfortable. I think it was 80% of that in the balance in the following year. And that's with both companies as we look at it. It's not just SV1s. It's also ours as we look at putting two good companies together. And I think we've evaluated that and very comfortable where we are and the deal costs the same thing coming in slightly under what we thought. So those are positives going forward.

If you remember the deal book, Russell, it was about $13.5 million expected plus saves up SV1's base and they run at about $3.8 million a month as a run rate for their expenses. So 30% off of that.

Great. Thank you both. That's it for me. Okay. Thank you.

The next question is from Steven Duong of RBC Capital Markets.

Hey, good morning, guys. Morning. Can you guys just go over just like the economic activity that you're seeing with reopening? How materially have things improved in the past couple of months?

I think first and foremost, a lot of our clients, when you look at retail exposure, a lot of them are anchored by grocery stores or essential businesses such as Walmart and the pharmacies, Home Depot and Lowe's. So the anchors have been supporting some of the other parts of those centers. We don't do large box. That said, restaurants, if they can do outdoor dining, I think everybody's getting that model It's difficult to get the saturation and the number of customers you used to get, but you're seeing that doing better. I don't think it's the panacea of everything else. So hotels, I think we talk about that being difficult if nobody's traveling, everybody's kind of staying in place. That's not going to help if we can't open up the other areas of the United States to a flowing economy. The other side would be kind of the gyms, fitness and wellness areas have been closed by the governor and until that opens up those businesses will still struggle and we hope that they're able to come back. Those are the question marks that I have. I don't know if Tom has anything else in that regard.

Thank you, Chris. Great, thanks there. And just any idea on latest rent collection numbers from your borrowers?

I don't have that number. I'm just trying to, we're just checking a couple of things real quick. That one, Steve, we'll have to get back to you on that one.

Sure, sure. No problem. And I guess the bully picked up this quarter. Should we expect it to kind of just track back down to where it was in the prior quarter?

Yes, that BOLI event, there was one, somebody who passed that came into the process. I think it was, you know, doing social security searches, they found out that someone who had been not with the bank for a long period of time found that they had passed. So that came in this quarter. So BOLI will go back to normal. And hopefully nobody's passing it.

I'm sorry, on the prior question, I was able to get a little information. They're running about 90% in terms of collections on BOLI. Okay, great.

That's good to hear. And then just last one for me. If we were to going forward, I guess, strip out the PPP impact, where do you think loan yields would kind of hover around?

So again, I guess the quick way to do that with the PPP was about 400 million for the quarter, let's say. And this concludes our question and answer session.

I would now like to turn the conference back over to Mr. Martin for any closing remarks.

Thank you very much. And as we've been experiencing, any economic recovery will not be smooth regardless of the political outcomes in November. Much of the economy is partially closed or beginning to open, with supply chain issues continuing. The pace and level of restrictions imposed by our political leaders at times seems out of touch. Many industries will take years to recover, and sadly, some will never make it. But we stand ready to assist our clients in any manner that promotes growth, yet with safety for you, our stockholders, and we appreciate your attention. Stay well and stay safe. Thank you.

Thank you. The conference is now concluded. Thank you all for attending today's presentation. You may now disconnect your lines. Have a great day.